How to not choose mutual funds

How to not choose mutual funds

So you have finally decided to start investing via mutual funds? After this smart decision, the next step is to choose which are the mutual funds you want to invest in. Do you, however, know what are you hoping to achieve in terms of returns? Knowing your personal investment goals is as important as starting to invest.

This is also where many investors go wrong. When investors don’t know what they are hoping to achieve, they end up choosing the wrong funds. Here are a few ways in which you can end up investing in wrong mutual funds.

Choosing based on hearsay

Peer recommendation is a major factor that influences many choices we make. Many mutual fund investors, thus, end up investing in funds because they know people who were investing in them.

In the case of mutual funds though, investors often end up choosing funds based on uninformed or incorrect advice.

Choosing small-cap equity mutual funds just because your trader friend invests in them, might not really work for you.

Choosing a mutual fund because it’s this year’s top-rated fund 

Ratings can be an incomplete indicator of a fund’s positive performance. In the case of mutual funds, many of last year’s top-rated funds fail to find a mention
in this year’s list.

It is far better to choose a fund that had delivered consistently over at least a five year period and has been in existence for more.

Choosing a mutual fund because of outstanding returns over the short term

Many investors get taken in by short-term performance. Some funds, during market peaks, have delivered extraordinary returns. This influences investors who end up ignoring long-term performance because the short-term performance looks too good.

When market conditions are right even bad funds can do well. Investors should, therefore, make it a point to check the long-term performance of the mutual funds that they are planning to invest in. 

Choosing a mutual fund purely based on returns

Returns seem to be the only focus for many new investors. Therefore, they end up choosing funds with the highest
one-year returns, as it seems failsafe
and easy. Without keeping your goals in mind though, such an approach can be
disastrous. If you need money in three years and you have chosen an equity fund
because it gives the highest returns
now, then what would you do if the market tanks in two years from now?

Mutual funds selections should be aligned with your goals, it’s timelines and needs, and not just returns.

Choosing funds only on the basis of low expense ratios

This is something slightly savvier investors fall prey to. Keeping total expense ratios in mind when choosing funds is important, but it should not be the sole criteria to base your selection on.

If a fund has a low expense ratio but has not performed consistently, then the low expense ratio hardly matters.

Stick to the basics

Choosing mutual funds is not simple, but if you know your timelines and goals, you have the most important starting point when it comes to choosing mutual funds.

Don’t get swayed by short-term performance. Focus instead on the consistency of returns over the long term.

(The writer is the founder & COO at Scripbox)